One simple application of this is that if two items have the same price, a person will buy the one that gives the most utility.
For example, if I go into the dollar store, and find that I could buy a one-pound bag of m&ms (for $1) or a plain calculator (also for $1), and I would get more pleasure (utility) from the m&ms (all things considered) I would buy the m&ms, since they give the greatest marginal utility per dollar spent.
Suppose that a consumer can buy some m&ms candy at the dollar store for a dollar ($1.00).
The alternative is to go to the grocery store next door and buy a larger bag of m&ms candy for $3.00.
The consumer feels that the MU he will get from the grocery store m&ms candy is about twice as great as the MU of the dollar-store bag of m&ms candy. Which would we expect the consumer to buy?
Since the grocery story candy gives the consumer twice as much utility, but will cost the consumer three times as much to buy as the dollar store candy, the consumer will buy the dollar store candy.
To see this, find MU/price = marginal utility per dollar spent on each kind of candy.
The consumer will buy the one that gives the most bang for the buck, or the most utility per dollar.
Since we need to compare the utility per dollar spent on the grocery store candy with the utility per dollar spent on the dollar store candy, we are comparing
but realizing that the grocery store candy gives twice as much utility as the dollar store candy does means that
MUgrocerystore = 2 x MUdollarstore
putting this together with the price information gives
So, since each dollar spent on candy in the grocery store only gives two-thirds as much utility as a dollar spent on candy in the dollar store, buying the dollar store candy is what the consumer will do to maximize utility.
Does that mean that this consumer should keep buying dollar store m&m’s forever?
No. Remember that the marginal utility from consuming or obtaining a good goes down the more of it that is consumed or obtained. This is called
The Law of Diminishing Marginal Utility,
which is an example of the law of diminishing returns.
When the MU per dollar spent is the same for all goods, a consumer will stop changing the “mix” or proportions of goods he consumes. There is no longer a clear way of maximizing utility by buying one good rather than another.
Here’s another example. Suppose a person is thinking of buying new clothes. Given her current wardrobe of shirts and jeans, she has a marginal utility of one additional pair of jeans of 60 units (which we will call "utils") and a marginal utility of one additional shirt of 30 units (utils).
What should she do, if the price of a pair of jeans is $30 and the price of a shirt is $10?
Her MU per dollar spent on jeans is 2 utils per dollar spent = 60/$30
Her MU per dollar spent on a shirt is 3 utils per dollar spent = 30/$10,
so she should buy another shirt. Buying the shirt will change the mix of clothes in her wardrobe, but that's what she wants to do, given these prices.
If buying the shirt lowers the marginal utility of another shirt to 20 utils, the difference in marginal utility per dollar spent will go away, and she will stop buying shirts in preference to jeans.